Why Is There a Bidding War to Buy Family Dollar?

A newly renovated Family Dollar store in the Bedford-Stuyvesant neighborhood of Brooklyn in New York
Richard Levine/Alamy

These aren't the best of times for discount retailers, but it certainly seems as if Family Dollar (FDO) has become the belle of the marked-down ball. Two chains catering to thrifty-minded shoppers have entered into an unlikely bidding war for Family Dollar, and it's shaping up to be a bit more interesting than your typical love triangle between three retailers with the name "Dollar" in their monikers.

The story began late last month when Family Dollar announced that it would be acquired by Dollar Tree (DLTR) in an $8.5 billion transaction. It seemed like a simple enough transaction. Dollar Tree would be paying a reasonable 22 percent premium for Family Dollar.

The deal would create a discounting behemoth with 13,000 stores across North America. The combined companies would eventually result in trimming $300 million in annual overhead.

It seemed like a great way out for frustrated Family Dollar shareholders. The deep discounter had missed Wall Street's profit targets for three consecutive quarters. Analysts see declining profitability on flat sales for its fiscal year that ends this week. It seemed as if Dollar Tree would have Family Dollar all to itself, but then it got some unexpected company.

Turning Down a Fistful of Dollars

Dollar General (DG) stepped into the picture last week, offering to pay even more for Family Dollar. It offered an all-cash deal valued closer to $9 billion. The deal seemed to be clearly superior on the surface, but Family Dollar's board shot it down.

%VIRTUAL-WSSCourseInline-884%This wouldn't be the first time that a board sided with a friendly buyout offer to a higher hostile one. Arranged deals often mean cushier positions for the acquired company. However, there was a method to the board's madness this time. Family Dollar declined Dollar General's offer because it felt that antitrust regulators wouldn't let that particular buyout go through.

Dollar General rings up more than twice as much in sales as Dollar Tree. The bigger the rivals are, the larger hurdle that they have to clear for a corporate combination to go through.

However, despite the "Dollar" name in the signage of all three, the chains aren't all alike. Dollar Tree is a true dollar store. It's North America's leading operator of discount variety stores where everything sells for a buck or less. Family Dollar and General Dollar are traditional deep discounters, offering general merchandise at various price points. They do help shoppers stretch their dollars, but they're not dollar stores like Dollar Tree.

The Buck Stops Here

Offering shoppers bargains isn't enough anymore. Walmart (WMT) -- the world's largest retailer and a bellwether when it comes to discount department stores -- has posted flat or negative comparable-store sales at its U.S. stores for six consecutive quarters. "Cheap chic" discount department store operator Target (TGT) has also been posting uninspiring sales, clocking in with flat store-level sales in its latest quarter.

Given the dicey environment, it's not a surprise to see deep discounters giving sector consolidation a hand. Family Dollar will get bought out. It may seem as if Dollar Tree has the upper hand with the lower bid, but it remains to be seen if it will have to sweeten its offer. We also can't rule out Dollar General, especially if it agrees to close enough stores to make the deal more likely to clear regulator objections.

Investors are encouraged to keep following the "Dollar" signs.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our newsletter services free for 30 days.

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